SPX Cyclical Bull Lives

Naturally in the wake of the recent stock-market selling, bearish theories
have made a major resurgence. You can't turn on CNBC for 5 minutes, let alone
open a financial newspaper, without seeing endless reasons why the stock markets
are doomed to spiral ever lower. But the little-discussed contrarian case against
these mainstream arguments is pretty compelling today.

It asserts the US stock markets remain in a powerful cyclical bull
(albeit within a secular bear). The 16% selloff in the flagship S&P 500
stock index (SPX) between late April and early July was simply a mid-bull correction.
Such events from time to time are perfectly normal and healthy, as they rebalance
sentiment to keep greed from getting out of hand before a bull fully runs its
course.

The implications of this bull/bear debate are certainly not trivial. If the
cyclical bull is dead as the bears assert, traders need to sell positions,
raise cash, and maybe get short. But if the cyclical bull lives, traders need
to buy positions, deploy cash, and get long. These diametrically-opposed outcomes
will be greatly leveraged in sectors that amplify underlying SPX moves including
commodities stocks and tech stocks. Being right or wrong at today's critical
juncture will make or break your entire year.

Before we pronounce the cyclical bull alive or dead, we first have to determine
if the rally since March 2009 is indeed a cyclical bull. Many bears, well aware
of what cyclical-bulldom portends, are arguing that all we've seen is a post-panic
bounce. Never mind that this "bounce" blasted 80% higher and persisted for over
13 months by late April!

How can we differentiate between bull and bounce? One way is to compare the
action since March 2009 with the most-recent cyclical bull before that. Between
October 2002 and October 2007, the SPX relentlessly powered nearly 102% higher
over a 60-month span. It is impossible to argue that this event wasn't a
cyclical bull, and even the most belligerent perma-bears readily admit and
accept this truth.

My first chart superimposes the recent 2009 and 2010 SPX action over the first
couple calendar years of that last cyclical bull, 2003 and 2004. That prior
event was incontrovertibly a cyclical bull, so if the rally since March 2009
tracks it well then we have nearly unassailable technical evidence that we
are indeed experiencing another cyclical bull today.

Despite being separated by a big 6-year gulf of time, the recent SPX action
tracks the early years of the previous cyclical bull nearly perfectly. Their
respective almost-interchangeable tracks are even carved near the same absolute
levels in SPX terms, which is pretty remarkable. This provocative comparison
slaughters the technical-bounce theory with extreme prejudice. There's no doubt
we've been enjoying a textbook cyclical bull since March 2009.

Back in late April, only the most diehard bears disputed this notion. The
cyclical-bull status of this past year's massive rally was generally accepted.
But today, thanks to the sharp correction since, the bearish camp is increasingly
undermining this assertion. Why? Because bears who are honest students of the
markets know well that cyclical bulls never end after merely a year,
even deep within the bowels of secular bears.

The big hang-up on today's cyclical bull is the severity and depth of the
recent correction. In the early years of the last cyclical bull, as well as
the initial year of today's, there were no corrections. Corrections are generally
classified as retreats greater than 10%. Anything less is merely a pullback.
As you can see above, in both cyclical bulls the latter lesser selling episodes
were the norm.

And after plunging 16% in 10 weeks ending earlier this month, the SPX is getting
perilously close to bear-market territory in many bears' minds. The classic
definition of a bear is a 20%+ decline off the previous interim high. When
you are already down 16%, a couple sizable down days is all it would take to
exceed this classic bear-market benchmark. And as everyone knows, there is
plenty of selloff-triggering bad economic news to go around these days.

With the fact that what we've witnessed since March 2009 inarguably has the
classic technical signature of a young cyclical bull, a critical question emerges
at today's all-important juncture. Can cyclical bulls recover from such large
corrections midstream? Or are corrections approaching 20% so devastating psychologically
that the bulls simply give up their ghosts right then? Do we have precedent
of cyclical bulls within secular bears falling so sharply and then rebounding
right back into their uptrends?

Before we dig into these questions, it is crucial to understand the difference
between secular and cyclical. Secular trends last for very long periods
of time, over a decade. Cyclical trends are much shorter, usually from 2 to
4 years. Cyclical trends oscillate within secular trends. A typical
17-year secular bear contains both cyclical bulls and cyclical bears, meandering
sequentially through this secular time frame.

Actually the US stock markets entered their latest secular bear in March 2000.
Over the last decade, the SPX has been relentlessly grinding sideways
to lower. I started warning investors about this coming period of stagnation
way back in 2000 and 2001,
years before this notion even started to enter Wall Street consciousness. I've
written on today's secular bear and its implications countless times since.

Knowing whether we are in a secular bull or secular bear is definitely the
single most-important strategic understanding investors can possess. It provides
the grand overarching roadmap from which all investing decisions can be properly
oriented for maximum profits. If you are not crystal-clear on secular bears,
and why we are in one now, read my Long
Valuation Waves 3 essay to get up to speed.

This next chart zooms out to compare our current secular bear with the previous
one that ran from 1966 to 1982. While each secular bear was dominated by a
seemingly-endless span of agonizing sideways grinds, the markets meandered
higher for years (cyclical bulls) and lower for years (cyclical bears) within
these long trading ranges. These mid-secular-bear cyclical moves always alternate
between bull and bear.

There is much to consider in this chart, but if you internalize it you will
radically increase your odds of making the right decisions regarding when to
expect cyclical bulls (go long) and cyclical bears (go short or weather the
selloffs in bonds or cash). This precedent also strongly makes the case that
today's cyclical bull in the US stock markets is not rolling over into a cyclical
bear again as the bears aggressively assert.

I marked every cyclical bull in each secular bear above so we have some reference
point on how long these events tend to last. Prior to today's cyclical bull
starting in March 2009, there was one other cyclical bull in our current secular
bear as well as four in the last secular bear straddling the 1970s. Their lifespans
are very telling, revealing that today's cyclical bull remains exceedingly
young.

In the last secular bear, its four cyclical bulls lasted for 26 months, 32
months, 24 months, and 33 months respectively. This averages 29 months with
a tight standard deviation since there were no significant outliers. The only
other cyclical bull in our current secular bear lasted for 60 months ending
in October 2007! But we can be conservative and use the shortest cyclical bull
of modern times as our lifespan reference point.

Between October 1974 and September 1976, the SPX powered 73% higher over a
24-month span. Incidentally, this cyclical bull occurred at the very same point
within the last secular bear as today's cyclical bull is at in today's secular
bear. That earlier cyclical bull also erupted after a sharp cyclical bear that
lopped 48% off the SPX by late 1974. Its whole technical profile is very similar
to today's in many ways.

Our current cyclical bull was just over 13 months old by late April 2010 when
the SPX started correcting. If the shortest mid-secular-bear cyclical
bull witnessed in modern times lasted 2 years, the average of all five before
today's approached 3 years, and the longest was 5 years, why on earth should
today's suddenly die at barely 1 year old?

If we are indeed in a cyclical bull, and there is zero doubt based on these
comparison charts, then we ought to expect a typical cyclical-bull lifespan.
And despite what the bears are saying today, a single year is simply far too
short. Precedent concedes today's bull could last as little as 2 years and
as long as 5 years, but 1 year is just silly. The bull-bear cycles within secular
bears are powerful and never short-circuited.

But what about the correction? Doesn't the SPX's recent sharp 16% plunge over
10 weeks overshadow cyclical-bull precedent? Doesn't it mean this time is different?
Not at all! In that very same 1974-to-1976 cyclical bull that lasted 2 years
in very similar conditions to today's, it witnessed a mid-bull 14% plunge over
9 weeks. The subsequent cyclical bull from 1978 to 1980 (33 months) endured
a 14% correction over 9 weeks and a brutal 17% one over just 6 weeks. Yet they
continued powering higher on balance.

While large corrections within mid-secular-bear cyclical bulls are far rarer
than the typical sub-10% pullbacks, they do indeed emerge from time to time.
And their bulls weather them and keep on plowing higher once sentiment is rebalanced.
So arguing that because the recent correction was so big that our cyclical
bull is in jeopardy just doesn't hold water based on historical precedent.
Big corrections happen, yet cyclical bulls stoically soldier on.

There are also plenty of other arguments for today's cyclical bull remaining
alive and well. Secular bears are not 17-year periods of falling prices as
often assumed, but 17-year periods of sideways-grinding prices. The parade
of cyclical bulls and cyclical bears creates a giant secular trading range.
In today's secular bear, this works out to roughly 750 to 1500 on the SPX.

Not only does this flagship index remain low in its secular range today, but
it just emerged out of its deepest lows of its entire secular bear in early
2009. Around 1100 now, the SPX remains closer to the lower end of this range
than the upper end. So in secular terms, the SPX still has lots of technical
headroom to power higher for the remainder of this cyclical bull. While I doubt
this one will get anywhere close to 1500, it could easily achieve 1350 (100%
total gain, just like the last cyclical bull).

The infamous stock panic in late 2008, the first true panic in
101 years, was driven by highly-irrational fear-drenched selling. In
its dark heart in October 2008, the SPX plummeted 30% in just 4 weeks! All
but the most hardcore and extreme perma-bears would agree that such a precipitous
plunge made no sense regardless of economic conditions. Well, that panic
started from 1200 in September 2008. So as long as we languish below
1200, like we are today, the SPX remains in panic territory. This is not
sustainable.

Another bearish argument used against today's cyclical bull persisting claims
that the SPX has to fall below its March 2009 lows before this secular
bear ends. I continue to be amazed at how many professional traders expect
a sharp crash or a new panic that will drag the markets below those deep mid-secular-bear
lows. But this argument also has no historical support.

Secular bears tend to see their worst lows near the middle of their 17-year
spans, late 1974 in the last one and early 2009 in today's. For the rest of
that 1970s secular bear, the stock markets never even came remotely close to
revisiting those brutal late-1974 lows again. In today's terms, the lowest
the SPX ever got after that mid-secular-bear point was roughly around 950.

Realize that secular bears are not about absolute price levels, but valuations.
Secular bears are born because stocks are driven to valuations that are far
too high to be sustained. The purpose of secular bears is to lock stocks in
a long sideways range until earnings have time to catch up with stock prices.
This means that the end of our current secular bear, probably in 2016, may
very well occur near or above the top (1500) of the SPX's long trading
range! We've almost certainly seen the worst lows already.

The 1970s secular bear started around 94 in the SPX, but was trading at a
high P/E ratio of 24.1x earnings. By October 1974 (the equivalent of our March
2009 lows), it had fallen to 62 with an 8.7x P/E ratio. Yet when that 17-year
secular bear ended in August 1982, the SPX was trading at 102 with the lowest
P/E ratio yet of 6.6x. Anything under 7x is dirt-cheap, and such extremely
low valuations are only seen at the ends of secular bears.

Realize that the end of the 1970s secular bear in SPX terms was actually 9% above
its start! Yet valuations still collapsed by 73% over this 17-year span.
So when perma-bears make arguments for new lows below March 2009's, realize
they haven't really studied secular bears. These are valuation events,
not price events. They are marked by sideways grinding, not a 17-year decline
to their worst price levels right near their ends.

Amazingly it is possible, even probable, that the SPX will end today's secular
bear around 2016 at a level slightly above the 1527 it started at in March
2000! And it is almost a certainty that this bear will end at SPX levels far
above the March 2009 lows. New lower price lows are no longer necessary
in this secular bear's second half. As corporate earnings gradually grow and
catch up with stock prices, valuations gradually decline even as prices steadily
climb out of their mid-secular-bear lows.

One more strategic observation. The first years of cyclical bulls, emerging
out of deeply-oversold cyclical-bear lows, are always the biggest. Following
the bad years of 2008 (-39%), 2002 (-23%), and 1974 (-30%), the SPX rallied
24% in 2009, 26% in 2003, and 32% in 1975. While cyclical bulls' second calendar
years aren't as good as the first, they are still pretty impressive. 2004 and
1976, the equivalent years to where we are in our cyclical bull today, saw
gains of 9% and 19%. Since we started 2010 at 1115 on the SPX, a 10% to 20%
rally would yield a year-end close of roughly 1225 to 1340. This is far higher
than today's levels!

There are just no sound secular arguments for either today's cyclical bull
dying in late April or a new crash or panic driving a retest of the epic March
2009 lows. Probabilities overwhelmingly favor the US stock markets continuing
to rally on balance for at least another year as today's cyclical bull reasserts
itself after its healthy correction. Interestingly sentiment also supports
this cyclical-bull-lives thesis.

This summer has been a rotten one sentiment-wise. Between the Marxists in
Washington hellbent on radically raising taxes on US investors, and the depressing
oil spill in the Gulf, investors and speculators haven't had many reasons to
be hopeful. But BP will almost certainly succeed in capping its blown-out well
in the coming weeks, removing that albatross. And the months leading up to
the critically-important November elections will give American investors much
hope that many Marxists will be thrown out of office. Today's poisoned sentiment
environment will dramatically improve in the coming months.

One of the primary beneficiaries of this continuing SPX cyclical bull will
be commodities stocks. They were hit hard in recent months as falling US
and China stock markets stoked demand fears. But as the SPX continues to
power higher in this cyclical bull, commodities stocks will surge and dramatically
outpace its gains. At Zeal we've been aggressively adding new high-potential
commodities-stock trades recently. It isn't too late to deploy your
own capital in these fantastic new trades at bargain prices.

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The bottom line is today's cyclical stock bull is very much alive and well.
At barely a year old, it is far too young yet to give up its ghost. The recent
big correction changes nothing, such events happen from time to time even within
healthy ongoing cyclical bulls. And the SPX not only remains low within its
secular trading range, but it is still trading in irrational panic territory.
This is an anomaly that cannot persist.

So not only are the stock markets likely to continue rallying for the rest
of 2010, but their gains should be strong. In order for this year to even come
close to conforming with cyclical-bull-within-secular-bear precedent, the SPX
needs to rally another 12% to 22% from today's levels. And leveraged
sectors like commodities stocks will soar in such a scenario, greatly amplifying
the broad-market gains.

If you have questions I would be more than happy to address
them through my private consulting business. Please visit www.zealllc.com/financial.htm for
more information.

Thoughts, comments, flames, letter-bombs? Fire away at zelotes@zealllc.com.
Due to my staggering and perpetually increasing e-mail load, I regret that
I am not able to respond to comments personally. I WILL read all messages though,
and really appreciate your feedback!

Mr. Hamilton, a private investor and contrarian analyst,
publishes Zeal Intelligence, an in-depth monthly strategic and tactical analysis
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